The adeno-associated virus type 2 (AAV) genome contains inverted terminal repeats (ITRs) of 145 nucleotides. The terminal 125 nucleotides of each ITR form palindromic hairpin (HP) structures that serve as primers for AAV DNA replication. These HP structures also play an important role in integration as well as rescue of the proviral genome from latently infected cells or from recombinant AAV plasmids. Each ITR also contains a stretch of 20 nucleotides, designated the D sequence, that is not involved in HP structure formation. We have recently shown that the D sequence plays a crucial role in high-efficiency rescue, selective replication, and encapsidation of the AAV genome and that a host cell protein, designated the D sequence-binding protein (D-BP), specifically interacts with this sequence (X.-S. Wang, S. Ponnazhagan, and A. Srivastava, J. Virol. 70:1668-1677, 1996). We have now performed mutational analyses of the D sequences to evaluate their precise role in viral DNA rescue, replication, and packaging. We report here that 10 nucleotides proximal to the HP structure in each of the D sequences are necessary and sufficient to mediate high-efficiency rescue, replication, and encapsidation of the viral genome in vivo. In in vitro studies, the same 10 nucleotides were found to be required for specific interaction with D-BP, but viral Rep protein-mediated cleavage at the functional terminal resolution site is independent of these sequences. These data suggest that AAV replication and terminal resolution functions can be uncoupled and that the lack of efficient replication of AAV DNA may not be a consequence of impaired resolution of the viral ITRs. These studies further illustrate that the D sequence-D-BP interaction plays an important role in the AAV life cycle and indicate that it may be possible to develop the next generation of AAV vectors capable of encapsidating larger pieces of DNA.